A New Manager Selection Process for Increased Diversity
The current asset-manager evaluation process only exacerbates existing inequities in financial services.
Investors increasingly tell asset allocators that they want manager diversity along with their financial returns, but traditional due-diligence and risk-assessment frameworks in the asset-management industry have led to a system in which white, male asset managers control 98.7% of the investment industry's $69 trillion in assets under management.
There are many talented Black asset managers, but assets aren't being allocated to us at scale. What's holding back our success? The answer lies in an outdated due-diligence process that maintains the status quo and keeps investments where they have always been, and that's not in the hands of Black folks.
The problem isn't due diligence itself; fiduciary and diligence considerations are absolutely necessary when taking care of money for clients. The problem lies in how the asset-manager evaluation process exacerbates existing inequities in financial services while also failing to account for diversity outcomes. If asset-manager racial diversity is what you want, you have to adjust your process to center that outcome.
In asset-manager due diligence, applicants must earn the possibility of being considered by answering lengthy questionnaires (I've seen one with over 1,000 questions) and navigating a time-consuming, and often burdensome, interview and paperwork-submission process.
While ostensibly intended to provide an objective evaluation of a manager's ability, these lengthy applications and traditional measurements do not actually explicitly assess an asset manager's skills or abilities.
What AUM and Track Record Actually Measure
Black managers typically face industry-standard thresholds for assets under management and track-record requirements that overwhelmingly favor those who already manage significant assets.
These standards are a difficult hurdle for any emerging manager: typically a minimum of $200 million under management and a three-year track record. But the AUM and track-record standards are disproportionately harder for Black asset managers to achieve.
The reason is that asset managers who are able to meet these thresholds are likely to have existing wealthy investor networks willing to invest based on relationship alone and/or have personal or family wealth to draw upon during the initial three-year period. But as a result of systemic inequities, Black people are both underrepresented in financial services and face an enormous wealth gap, so they are far less likely to have the advantages that enable other asset managers to meet these thresholds.
Due-diligence processes that require these thresholds be met, or offer exemptions from these requirements based on relationships (and who gets exemptions from the requirements is a topic worth considering), exacerbate systemic racism in financial services. The problem is systemic, so we need to rethink our systems.
Commit to Better Systems
Forward-thinking asset allocators can update their due-diligence processes in a number of ways to be more inclusive. In an effort to provide actionable changes, over a dozen BIPOC (Black and Indigenous people of color) managers in collaboration with the investment committee of a multi-billion-dollar allocator created the Due Diligence 2.0 Commitment. It includes nine specific shifts that allocators can make in the due-diligence process to remove systemic barriers to Black, Indigenous, and other asset managers of color, while continuing to meet fiduciary responsibilities. You can find the full commitment document here, along with a way to sign on. Here's a shortened version of the nine behavior shifts:
1) Consider Track-Record Alternatives
For newer strategies or products, instead of insisting on a specific minimum track record for the product, evaluate members of the investment and leadership team based on past experience, investment sourcing capabilities, and domain expertise, as well as assess prior track records in related or relevant work.
2) Expand What It Means to 'Work Together'
Particularly for private-market investments, the management team is often evaluated based on how long its members have worked together. However, for BIPOC managers, opportunities to "work together" or "invest together" at existing asset-management firms are few and far between. Instead, take into consideration the time individual investment managers have worked together while building the firm and in other organizations to evaluate the stability of the partnership.
3) Reassess AUM as a Risk Metric
Instead of using AUM as a proxy for the financial stability of a manager, commit to evaluating the manager's history of operating effectively with lower-than-industry-standard budgets; growth momentum in AUM; AUM growth in previous positions at prior firms; and what happens to the underlying investments in the event of firm insolvency. In many cases, when a manager becomes insolvent, the underlying assets are simply apportioned pro rata to the investors. If this is true for a product you are considering as an allocator, re-evaluate the true risk of loss to the investor and whether AUM is an appropriate indicator.
4) Respect BIPOC Time
Reports from BIPOC managers conclude that while they have committed extensive time to due-diligence conversations and formulating written responses to questions, very little capital has actually moved to their management. Recognizing that time is the most precious commodity for BIPOC managers, minimize requests for meeting time with managers and, if possible, convene group meetings in which managers can answer questions for multiple asset allocators at once. Condense, standardize, and/or support managers in completing due-diligence questionnaires.
5) Contextualize Fees
Rather than eliminating BIPOC managers from consideration because of higher fees, compare the services they provide with those of peer managers. (For example, does the BIPOC manager require more staff or outsourced partnerships to collect data from impacted communities?) Additionally, because higher fees are often correlated with lower AUM, consider allowing for initial high fees predicated on a manager projection for future fee reductions tied to fundraising success.
6) Include Historically Unrecognized Risks
To the extent you consider market inefficiencies or underpriced risks in your investment philosophy and analysis, consider evaluating the potential risks and costs of BIPOC undercapitalization in your analysis.
7) Be Willing to Go First
Consider being an anchor/seed investor or part of a first close (or in the case of a mutual fund or exchange-traded fund, at/near fund inception) rather than insisting on being in later closes.
8) Offer Transparency About Remaining Hurdles
If after the aforementioned revisions you still have specific minimum thresholds, explicitly state those at the outset to BIPOC managers. If the managers find them overly burdensome, they have the opportunity to invest their time in other opportunities.
9) Provide Detailed Feedback
If you choose not to invest with a BIPOC manager who has engaged in your due-diligence process, provide clear, specific, and timely feedback regarding the reasons for rejection. This creates a new opportunity for mentorship and professional growth for managers who may have lacked access to these resources in the past.
By actively dismantling systemic barriers for Black asset managers, we can meet asset-owner demand and make finance a more diverse and inclusive industry.
Rachel J. Robasciotti is the founder and CEO of Adasina Social Capital, an investment and financial activism firm that serves as a critical bridge between financial markets and social justice movements. Adasina was built out of the social justice investing strategy originally developed at Robasciotti & Philipson, an investment firm Rachel founded in 2004. As a queer, woman of color, Rachel is a fierce advocate for social justice in the financial industry. The views expressed in this article do not necessarily reflect the views of Morningstar.